Connect with us

Markets in a Minute

The Effects of Quantitative Tightening: Less Liquidity, More Volatility



This infographic is available as a poster.

Chart of S&P 500 liquidity and volatility

Chart of S&P 500 liquidity book depth

This infographic is available as a poster.

Quantitative Tightening: Less Liquidity, More Volatility

How are interest rate hikes and quantitative tightening affecting markets?

The Federal Reserve’s fast-paced rate hikes and initial reductions of its balance sheet have resulted in liquidity drying up across markets, amplifying volatility and uncertainty.

This Markets in a Minute from New York Life Investments explains how quantitative tightening affects markets, and charts the rise in volatility spurred by the severe decline in S&P 500 futures book depth.

What is Quantitative Tightening (QT)?

Quantitative tightening (QT) is the infamous twin to quantitative easing (QE). For context, quantitative easing is the injection of liquidity into bond markets by the Federal Reserve buying Treasuries and mortgage-backed securities which are added onto the Fed’s balance sheet.

As a result, during periods of quantitative easing, Treasuries and certain mortgage-backed securities have a large-scale buyer providing buy-side liquidity, reducing the impact of sellers in the market. This supports bond prices, and prevents bond yields from rising too quickly.

Quantitative tightening is a reduction of the assets on the Federal Reserve’s balance sheet. This means letting Treasuries mature and not rebuying them, or even selling them on the market. Opposite to quantitative easing, QT removes buy-side liquidity from the market and can result in bond prices falling and yields rising.

How Rate Hikes and Quantitative Tightening Affect Markets

Along with quantitative tightening’s reduction of liquidity from markets, interest rate hikes can also result in less market liquidity.

As interest rates rise, so do borrowing costs for capital. This results in less money being lent out and fewer deals being funded, higher mortgage and other loan rates, and tighter overall purse strings of market participants and everyday consumers. In this way, higher interest rates slow down market and economic activity.

The Fed’s pace of rate hikes in 2022 has been one of the fastest in history, with the Federal Funds rate starting the year at 0.0-0.25% and projected to end the year somewhere between 4.0-4.5%.

DateChange in Rates (bps)Federal Funds Rate
March 2022+250.25-0.50%
May 2022+500.75-1.00%
June 2022+751.50-1.75%
July 2022+752.25-2.50%
September 2022+753.00-3.25%

Source: Federal Reserve

As rates have continued to rise, the rate of quantitative tightening doubled in September to now let a maximum of $60 billion of Treasuries and $35 billion of mortgage-backed securities roll off its balance sheet without repurchase.

This acceleration in QT could see market liquidity dry up even more, further amplifying volatility.

How Low Liquidity and High Volatility Raise Risk

One of the clearest measures of liquidity is a market’s book depth. Book depth is the amount of available buy and sell orders in a market’s order book.

More orders stacked up on either side results in thicker book depth, or deeper liquidity for incoming buy and sell orders to tap into, while less orders on either side result in thinner book depth, especially at the top of the book.

The top of the book is where buy and sell orders are closest to the last traded price:

  • $101 – Closest sell orders
  • $100 – Current/last traded price
  • $99 – Closest buy orders

In the example above, buy orders at $101 and sell orders at $99 are at the top of the order book since they are closest to the last traded price.

As liquidity tightens and book depth thins out, orders at the top of the book become smaller, meaning that prices can move around more easily as big trades come into the market to fill orders at the top of the book.

In this way, tighter liquidity and thinner book depth result in higher volatility, largely raising risk for market participants. This can turn into a self-reinforcing cycle, as investors sit out of the markets to avoid periods of high volatility, resulting in even less liquidity and higher volatility.

Looking Ahead

As book depth has thinned out significantly over the past year, volatility began to rise alongside the market’s uncertainty.

With more rate hikes incoming and the Fed’s QT operations continuing at a faster pace now, market participants may brace for even less liquidity in markets and the possibility for further volatility and heightened risk.

Advisor channel footer

Thank you!
Given email address is already subscribed, thank you!
Please provide a valid email address.
Please complete the CAPTCHA.
Oops. Something went wrong. Please try again later.

Continue Reading

Markets in a Minute

What is the Success Rate of Actively Managed Funds?

For actively managed funds, the odds of beating the market over the long run are like finding a needle in a haystack.



Actively Managed Funds

What is the Success Rate of Actively Managed Funds?

Over a 20-year period, 95% of large-cap actively managed funds have underperformed their benchmark.

The above graphic shows the performance of actively managed funds across a range of fund types, using data from S&P Global via Charlie Bilello.

Missing the Mark: Actively Managed Funds

Several factors present headwinds to actively managed funds.

  • Trading costs: First, fund managers will trade more often than passive funds. These in turn incur costs, impacting returns.
  • Cash holdings: Additionally, many of these funds hold a cash allocation of about 5% or more to capture market opportunities. Unlike active funds, their passive counterparts are often fully invested. Cash holdings can have the opposite effect than intended—dragging on overall returns.
  • Fees: Active funds can charge up to 1-2% in investment manager fees while funds that tracked an index passively charged just 0.12% on average in 2022. These additional costs add up over time.

Below, we show how active funds increasingly underperform against their benchmark over each time period.

Fund Type1 Year
% Underperformed
5 Year
% Underperformed
10 Year
% Underperformed
20 Year
% Underperformed
All Large-Cap 51879195
All Small-Cap 57718994
Large-Cap Growth 74869698
Large-Cap Value 59698587
Small-Cap Growth 80598597
Small-Cap Value 41819192
Real Estate 88627487

As we can see, 51% of all large-cap active mutual funds underperformed in a one-year period. That compares to 41% of small-cap value funds, which had the best chance of outperforming the benchmark annually. Also, an eye-opening 88% of real estate funds underperformed.

For context, Warren Buffett’s firm Berkshire Hathaway has beat the S&P 500 two-thirds of the time. Even the world’s top stock pickers have a hard time beating the market’s returns.

2020 Market Crash: A Case Study

How about active funds’ performance during a crisis?

While the case for actively managed funds is often stronger during a market downturn, a 2020 study shows how they continued to underperform the index.

Overall, 74% of over 3,600 active funds with $4.9 trillion in assets did worse than the S&P 500 during the 2020 market plunge.

Stage of 2020 CycleTime Period% Underperforming S&P 500
CrisisFeb 20 - Apr 30, 202074.2
CrashFeb 20 - Mar 23, 202063.5
RecoveryMar 24 - Apr 30, 202055.8
Pre-CrisisOct 1 2019 - Jan 31, 202067.1

Source: NBER

In better news, roughly half underperformed through the recovery, the best out of any market condition that was studied.

The Bigger Impact

Of course, some actively managed funds outperform.

Still, choosing the top funds year after year can be challenging. Also note that active fund managers typically only run a portfolio for four and a half years on average before someone new takes over, making it difficult to stick with a star manager for very long.

As lower returns accumulate over time, the impact of investing in active mutual funds can be striking. If an investor had a $100,000 portfolio and paid 2% in costs every year for 25 years, they would lose about $170,000 to fees if it earned 6% annually.

Advisor channel footer

Thank you!
Given email address is already subscribed, thank you!
Please provide a valid email address.
Please complete the CAPTCHA.
Oops. Something went wrong. Please try again later.

Continue Reading

Markets in a Minute

Ranked: The Largest Bond Markets in the World

The global bond market stands at $133 trillion in value. Here are the major players in bond markets worldwide.



The Largest Bond Markets in the World

The Largest Bond Markets in the World

In 2022, the global bond market totaled $133 trillion.

As one of the world’s largest capital markets, debt securities have grown sevenfold over the last 40 years. Fueling this growth are government and corporate debt sales across major economies and emerging markets. Over the last three years, China’s bond market has grown 13% annually.

Based on estimates from the Bank for International Statements, this graphic shows the largest bond markets in the world.

ℹ️ Total debt numbers here include both domestic and international debt securities in each particular country or region. BIS notes that international debt securities are issued outside the local market of the country where the borrower resides and cover eurobonds as well as foreign bonds, but exclude negotiable loans.

Ranked: The World’s Top Bond Markets

Valued at over $51 trillion, the U.S. has the largest bond market globally.

Government bonds made up the majority of its debt market, with over $26 trillion in securities outstanding. In 2022, the Federal government paid $534 billion in interest on this debt.

China is second, at 16% of the global total. Local commercial banks hold the greatest share of its outstanding bonds, while foreign ownership remains fairly low. Foreign interest in China’s bonds slowed in 2022 amid geopolitical tensions in Ukraine and lower yields.

Bond Market RankCountry / RegionTotal Debt OutstandingShare of Total Bond Market
1🇺🇸 U.S.$51.3T39%
2🇨🇳 China$20.9T16%
3🇯🇵 Japan$11.0T8%
4🇫🇷 France$4.4T3%
5🇬🇧 United Kingdom$4.3T3%
6🇨🇦 Canada$4.0T3%
7🇩🇪 Germany$3.7T3%
8🇮🇹 Italy$2.9T2%
9🇰🇾 Cayman Islands*$2.7T2%
10🇧🇷 Brazil*$2.4T2%
11🇰🇷 South Korea*$2.2T2%
12🇦🇺 Australia$2.2T2%
13🇳🇱 Netherlands$1.9T1%
14🇪🇸 Spain$1.9T1%
15🇮🇳 India*$1.3T1%
16🇮🇪 Ireland$1.0T1%
17🇲🇽 Mexico*$1.0T1%
18🇱🇺 Luxembourg$0.9T1%
19🇧🇪 Belgium$0.7T>1%
20🇷🇺 Russia*$0.7T>1%

*Represent countries where total debt securities were not reported by national authorities. These figures are the sum of domestic debt securities reported by national authorities and/or international debt securities compiled by BIS.
Data as of Q3 2022.

As the above table shows, Japan has the third biggest debt market. Japan’s central bank owns a massive share of its government bonds. Central bank ownership hit a record 50% as it tweaked its yield curve control policy that was introduced in 2016. The policy was designed to help boost inflation and prevent interest rates from falling. As inflation began to rise in 2022 and bond investors began selling, it had to increase its yield to spur demand and liquidity. The adjustment sent shockwaves through financial markets.

In Europe, France is home to the largest bond market at $4.4 trillion in total debt, surpassing the United Kingdom by roughly $150 billion.

Banks: A Major Buyer in Bond Markets

Like central banks around the world, commercial banks are key players in bond markets.

In fact, commercial banks are among the top three buyers of U.S. government debt. This is because commercial banks will reinvest client deposits into interest-bearing securities. These often include U.S. Treasuries, which are highly liquid and one of the safest assets globally.

As we can see in the chart below, the banking sector often surpasses an economy’s total GDP.

Banking Sector

As interest rates have risen sharply since 2022, the price of bonds has been pushed down, given their inverse relationship. This has raised questions about what type of bonds banks hold.

In the U.S., commercial banks hold $4.2 trillion in Treasury bonds and other government securities. For large U.S. banks, these holdings account for almost 24% of assets on average. They make up an average 15% of assets for small banks in 2023. Since mid-2022, small banks have reduced their bond holdings due to interest rate increases.

As higher rates reverberate across the banking system and wider economy, it may expose further strains on global bond markets which have expanded rapidly in an era of dovish monetary policy and ultra-low interest rates.

Advisor channel footer

Thank you!
Given email address is already subscribed, thank you!
Please provide a valid email address.
Please complete the CAPTCHA.
Oops. Something went wrong. Please try again later.

Continue Reading


Are you a financial advisor?

Subscribe here to get every update, including when new charts or infographics go live:

Thank you!
Given email address is already subscribed, thank you!
Please provide a valid email address.
Please complete the CAPTCHA.
Oops. Something went wrong. Please try again later.